Now, with projected deficits reaching $1 trillion in 2025, this issue will eventually have to be addressed.

And when it is, one clear victim will emerge…

Let’s Review the Predicament

The new projection for 2015’s deficit is only $1 billion higher than 2014’s actual deficit, but the trend is disquieting.

Since the previous projection in January, the estimated outlays for student loans, Medicare and Medicaid have increased by net $18 billion. Those three programs are creating the biggest dangers when it comes to future cost overruns.

Tack on social security, and the tandem represents the gravest threat to budget balance in the coming years.

The central problem is based on demographics.

As the Baby Boomers retire and age to a point at which their healthcare needs escalate, the U.S. budget picture will inevitably deteriorate. Apart from the increasing cash flow deficit on social security, which will exhaust the “trust fund” by 2033, the Medicare and disability program trust funds are in even worse shape, with the disability trust fund scheduled to run out of money next year.

Whether Republican or Democrat, the next president is going to have to deal with this.

We’re currently within a couple of years of the longest continued upswing in U.S. history. So the chance is very high that a financial crash and economic downturn will hit in the next couple of years.

If and when that happens, the deficit will balloon – just as it did in 2008 to 2009. Even attempts by Congress or the president to throw public money at the problem (under the misguided Keynesian theory that this will help matters) won’t stop the tide.

Based on the last precedent, we could easily hit a budget deficit of $2 trillion, at which point it really would become difficult to finance.

Japan has suffered this problem since the 1990s, with endless “stimulus” infrastructure spending programs to try to lift the economy out of its malaise. The result is a public debt level of 240% of GDP. And there’s most likely no way for the country to return to sound financing without a default.

However, should the United States get into a Japanese position, its outlook would be worse than Japan’s.

You see, Japan runs a fairly consistent balance of payments surplus. And the great majority of its government debt is held by its own people, or by pension funds and savings banks doing business domestically. Thus it can run up huge amounts of debt without too much risk of a market panic.

The United States, however, has a $500-billion annual balance of payments deficit. And much of its debt is held by foreigners – not all of them friendly. So if the United States ever got close to the Japanese debt position, it would have to retrench drastically. That would involve cutting spending or raising taxes to bring its budget close to balance and begin paying down its debt.

That being said, there aren’t many areas in which the United States could retrench.

Options Are Limited

Defense spending of around $600 billion can’t be significantly cut back in a dangerous world.

Other domestic discretionary spending is only $592 billion. Much of that is undoubtedly waste, like agriculture subsidies. But, arithmetically, it’s likely impossible to cut more than $200 billion or so out of it.

Therefore, to reduce a deficit of $1 trillion-plus significantly, we would be forced to do one of two things…

For one, they could increase taxes sharply. This would be very difficult. Doing so would knock back GDP itself, thus reducing federal receipts by a substantial fraction of the new taxes imposed.

However enthusiastic the left may be to squeeze the orange of the “rich” further, there isn’t all that much juice there. So most additional revenue would have to come from the middle class, something that’s politically unpopular and economically damaging.

That only leaves the second choice – attacking “mandatory” spending, or entitlements.

Senior Citizens Are Walking Targets

Indeed, apart from student loans, the opportunities for budget savings are concentrated in Medicare and social security payments – along with other programs that benefit mainly senior citizens.

State pension funds are in big trouble, too, which can’t be avoided forever.

Senior citizens have only one defense against this: voting, which they do in much greater numbers than the young. That can hold off their greedy fellow citizens for a time. But eventually, further resistance will be futile.

I bet that retribution can be held off for another decade or so. But expect it to hit in the early 2030s. For two reasons…

First, the social security trust fund will run out in 2033, which will at least require a major arithmetical budget adjustment.

Second, the Baby Boomers will start dying in large numbers. And in the last six months of their lives, they will each incur half of their lifetime medical expenditures, according to current trends. That will deliver an extra sharp kick to the federal budget just when it doesn’t need it.

Bottom line: If you’re between 45 and 65 today, don’t plan on a prosperous retirement. You’re unlikely to get one!

Good investing,

Martin Hutchinson

For 27 years, Martin Hutchinson was an international merchant banker in London, New York, and Zagreb. He ran derivatives platforms for two European banks before serving as director of a Spanish venture capital company, advisor to the Korean company Sunkyong, and chairman of a U.S. modular building company. Learn More >>

How is it that the politicians always talk about
Social Security is gonna run out of money, but
now they want to add millions of illegal immigrants
on it. Had they not stole our SS, and had stayed in an annuity ,there would be plenty of money in it.

How about I get the choice of the fed paying me back all the money I and my employers put into the Social Security fund in one lump sum – and let ME do the ‘investing’? The reason Social Security is in such trouble is because the fed long ago spent the incoming funds, planning on most folks never LIVING to collect it. That, and letting darned near everyone collect SS whether they put a dime into it or not.

Every time President Trump rails against the media, he adds millions in market capitalization to The New York Times Company (NYT). So buying a few call options on NYT is virtually certain to pay off. If you’ve never traded options, fear not. I asked my senior analyst, Martin Hutchinson, to describe options so that a kindergartener would understand.